Flashcards · H060 · Topic 3

Market failure and government intervention flashcards

25 cards on Topic 3, subtopics 3.1 to 3.5. Pick a subtopic or study them all.

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Market failure: The free market fails to allocate resources efficiently (MSB is not equal to MSC), so too much or too little is produced or consumed.
Public good (OCR description): Non-excludable and non-rival (non-diminishable), also non-rejectable, with a zero marginal cost of an extra user.
Free-rider problem: Users get the benefit of a non-excludable good while leaving the cost to others, so it cannot be sold profitably and the market may not provide it.
Merit good vs demerit good: Merit good: under-consumed because consumers undervalue its benefits. Demerit good: over-consumed because consumers underestimate its harm or overestimate its benefit.
Quasi-public good: A good with some public-good features, or with them only up to a point, such as a road that becomes congested (rival) at busy times.

Externality, and the social cost and benefit identities: A cost or benefit that lands on someone outside the transaction and is left out of the price. MSC = MPC + MEC. MSB = MPB + MEB.
Diagram: negative production externality: MSC lies above MPC (supply). The market produces where MPC = MPB; the social optimum, where MSC = MSB, is lower. The welfare loss is the triangle between MSC and MSB over the extra output.
Diagram: positive consumption externality: MSB lies above MPB (demand). The market consumes less than the social optimum where MSB = MSC. The welfare loss is the triangle between MSB and MSC over the missing output.
The three roles of the environment: Provider of resources (raw materials, energy, water, food), provider of amenities (landscape, clean air, recreation) and absorber of waste, up to a limit.
Tradable pollution permit: A tradable right to emit a set amount, with the total capped. It fixes the quantity of pollution and lets trading set the price, so cuts are made where they are cheapest.

Information failure: Economic agents lack, or misjudge, the information needed for a good decision, so price signals mislead and resources are misallocated.
Asymmetric information: Buyer and seller hold unequal knowledge about the good, as in second-hand cars, insurance or financial advice.
Moral hazard: A change in behaviour after risk has been transferred, because the person no longer bears the full cost (for example, taking less care once insured).
Asymmetric information vs moral hazard: Asymmetric information is unequal knowledge, before or at the deal. Moral hazard is changed behaviour after cover is given.
Ways to reduce information failure: Information provision and campaigns, compulsory labelling and disclosure, regulation of advice and standards, guarantees and independent ratings.

Indirect tax on a demerit good: effect: Supply shifts left by the tax; price rises and quantity falls towards the social optimum. Tax revenue is a transfer; the deadweight-loss triangle is the welfare cost. It works less when demand is inelastic.
Subsidy on a merit good: effect: Supply shifts right by the subsidy; price falls and consumption rises towards the social optimum. Cost to government = subsidy per unit × new quantity.
Maximum price vs minimum price: Maximum price: set below equilibrium; causes a shortage. Minimum price: set above equilibrium; causes a surplus.
Buffer stock scheme: An agency buys when the price falls to the floor and sells from stock when it reaches the ceiling, to keep the price within a band.
Regulation vs tradable permits: Regulation sets a fixed rule for each firm. Permits fix the total and let trading decide the price and who cuts.
Other forms of intervention: State provision (of public and merit goods), information provision, and extending property rights.

Government failure: Intervention that makes the allocation of resources worse, causing a net welfare loss.
Market failure vs government failure: Market failure: the market gets the allocation wrong. Government failure: the intervention gets it wrong.
Causes of government failure: Distortion of price signals, unintended consequences (such as black markets), excessive administrative costs, and information gaps such as not knowing the true size of an externality.
Why might a minimum price on a farm product cause government failure?: Set above equilibrium it creates a surplus the government must buy and store or destroy, at a cost to taxpayers, while consumers pay more.